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The Berlin Wall of Aid: When Will It Fall?

The Berlin Wall of Aid: When Will It Fall?

Top-down economic development in Africa hasn’t worked. Here’s an alternative.

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By GLENN HUBBARD, Wall Street Journal – November 9, 2009

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On November 9, Germany and the world will celebrate the 20th anniversary of the fall of the Berlin Wall. The fall marked the end of Eastern Europe’s failed system of state-run economic development. But systems of top-down economic development continue in most of the poor countries of the world, where aid donors continue to fund government development projects despite their decades of failure. Why is this so? Why has the “Berlin Wall of Aid” not fallen despite its record of failure?

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The answer is simple: the Soviet Union controlled the system throughout Eastern Europe. Once Mikhail Gorbachev decided to stop supporting the system by force, it crumbled. In poor countries today, the system is fragmented among dozens of unconnected national governments and dozens of unconnected aid donors. There is no Gorbachev to pull the plug. So the failing aid system continues, and unfortunately, there is no obvious remedy on the horizon.

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The failure is not hard to diagnose. Prosperous countries developed their wealth through the growth of a domestic business sector. India and China are only the most recent examples. A thriving local business sector is the only path to prosperity and business the world has ever known.

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Let’s look at the World Bank’s Doing Business report, which ranks countries by how easy it is for local citizens to start and run businesses. Among 183 countries, the former Soviet Union make up 20 in the top half and only eight in the bottom half. Georgia is highest at 11 and Tajikistan is lowest at 152. From sub-Saharan Africa, only six countries are in the top half while 38 are in the bottom half. Mauritius is highest at 17, and the Central African Republic is lowest at 183. The former Soviet bloc has come a long way in its shift from government economic development to the local business sector. But Africa has much, much further to go.

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There have been three recent calls to tear down Africa’s aid wall: George Ayittey’s Africa Unchained, William Easterly’s White Man’s Burden, and Dambisa Moyo’s Dead Aid. Many observers agree with them, but these calls fall mostly on deaf ears among the people in power: the heads of aid agencies and the leaders of poor countries. It is in the interest of many of them for aid to continue. In our recent book “The Aid Trap: Hard Truths About Ending Poverty,” my colleague William Duggan and I suggest an alternative. Instead of halting aid, we can shift much of it from government-directed projects to the local business sector. And we have a compelling precedent — the Marshall Plan of post-war Europe. It made loans to local businesses, which paid them back to their local governments, who then used the money for commercial infrastructure to help those same businesses.

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The world recognizes the Marshall Plan as the most successful aid program in history. We find smaller versions in post-war Japan, South Korea and Taiwan, and in Eastern Europe – as Enterprise Funds – after the fall of the Wall. But the central mechanism of the Marshall Plan can adapt to any kind of economy. Post-war Greece was small, war-torn and very poor–in some respects like most of Africa today–and the Marshall Plan in Greece was a great success.

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Can the aid system shift, or is it too inflexible – like the Soviet system was – to adapt to a new Marshall Plan? We can find some encouragement in two changes in the aid system over the past two decades: it has accommodated NGO projects and microfinance alongside government programs. Humanitarian aid especially works best through NGOs, and microfinance has helped millions of poor people start and run micro-businesses across the world. These major shifts over the past two decades show that the aid system has some ability to adapt beyond its traditional form of government development projects.

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But NGOs can’t raise people out of poverty — only local business can do that. And microfinance operates in most poor countries below the radar with unregistered companies that can’t get formal loans or join the normal business sector. Small and medium-sized businesses, not microfinance, generate the jobs and demand that lift poor countries out of poverty. That’s how it happened in Western Europe, the United States, East Asia and now China and Eastern Europe.

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A Marshall Plan would continue aid to poor countries, but directs it in a way that can actually lead to prosperity. The growth of NGOs and microfinance show that the aid system can adapt. But the shift to local business will be harder, because it is a more fundamental change of the economic system. NGOs and microfinance can operate alongside government development projects while local businesses are a direct alternative to them.

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The Marshall Plan might not be the only way to shift large amounts of aid to the local business sector in poor countries. If there is an easier or faster way, all the better. But the time has come for the Berlin Wall of aid to fall. Sub-Saharan Africa is as poor today as it was 50 years ago despite increases in foreign aid.

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The Berlin Wall lasted only 28 years, from 1961 to 1989. How long will the aid wall last? Who will tear it down?

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Mr. Hubbard, dean of Columbia Business School, was chairman of the U.S. Council of Economic Advisers from 2001 to 2003. He and William Duggan are co-authors of “The Aid Trap: Hard Truths About Ending Poverty” (Columbia, 2009).